Chapter 4 The Accounting Cycle: Accruals and Deferrals

for the purpose of measuring income and preparing financial statement, the life of a business is divided into a series of...

accounting periods

timing differences between cash flows and the recognition of revenue and expenses are referred to as...

accruals and deferrals

adjusting entries are only made...

at the end of each accounting period

adjusting entries to convert assets to expenses result from...

cash being prior to an expense being incurred

adjusting entries to convert liabilities to revenue result from...

cash being received prior to revenue being earned

the practice of accounting periods enables decision makers to...

compare the financial statements of successive periods and to identify significant trends

four types of adjusting entries...

converting assets to expenses, converting liabilities to revenue, accruing unpaid expenses, and accruing uncollected revenue

adjusting entries to accrue unpaid expenses result from...

expenses being incurred before cash is paid

converting liabilities to revenue

customers sometimes pay in advance for services to be rendered in later accounting periods. For accounting purposes, the cash received does not represent revenue until it has been earned. Thus, the recognition of revenue must be deferred until it is earned. Advance collections from customers are recorded by debiting Cash and by crediting a liability account for unearned revenue. This liability is sometimes called Customer Deposits, Advance Sales, or Deferred Revenue. As unearned revenue becomes earned, an adjusting entry is made at the end of each period to transfer an appropriate amount from the liability account to a revenue account. This adjustment reflects the fact that all or part of the company's obligation to its customers has been fulfilled and that revenue has been realized

adjusting entries assign revenues to the period in which they are...

earned

two important characteristics of all adjusting entries...

every adjusting entry involves the recognition of either revenue or expenses & adjusting entries are based on the concepts of accrual accounting, not upon monthly bills or month-end transactions

fourth step of the accounting cycle...

performing the end-of-period adjustments required to measure business income

first three steps of the accounting cycle...

recording transactions, posting transactions, and preparing a trial balance

adjusting entries assign expenses to the period in which...

related good or services are used

adjusting entries to accrue uncollected revenue result from...

revenue being earned before cash is received

problem of measuring net income for a relatively short accounting period...

some business activities affect the revenue and expenses of multiple accounting periods

accruing unpaid expenses

some expenses accumulate (or accrue) in the current period but are not paid until a future period. These accrued expenses are recorded as part of the adjusting process at the end of each period by debiting the appropriate expense (e.g., Salary Expense, Interest Expense, and Income Taxes Expense), and by crediting a liability account (e.g., Salaries Payable, Interest Payable, and Income Taxes Payable). In future periods, as cash is disbursed in settlement of these liabilities, the appropriate liability account is debited and Cash is credited. Note: Recording the accrued expense in the current period is the adjusting entry. Recording the disbursement of cash in a future period is not considered an adjusting entry

accruing uncollected revenues

some revenues are earned (or accrued) in the current period but are not collected until a future period. These revenues are normally recorded as part of the adjusting process at the end of each period by debiting an asset account called Accounts Receivable, and by crediting the appropriate revenue account. In future periods, as cash is collected in settlement of outstanding receivables, Cash is debited and Accounts Receivable is credited. Note: Recording the accrued revenue in the current period is the adjusting entry. Recording the receipt of cash in a future period is not considered an adjusting entry

purpose of adjusting entries...

to assign to each accounting period appropriate amounts of revenue and expense

adjusting entries are needed at the end of each accounting period...

to make certain that appropriate amounts of revenue and expense are reported in the company's income statement

converting assets to expenses...

when an expenditure is made that will benefit more than one accounting period, an asset account is debited and cash is credited. The asset account is used to defer (or postpone) expense recognition until a later date. At the end of each period benefiting from this expenditure, an adjusting entry is made to transfer an appropriate amount from the asset account to an expense account. This adjustment reflects the fact that part of the asset's cost has been matched against revenue in the measurement of income for the current period

adjusting entries are needed...

whenever transactions affect the revenue and expenses of more than one accounting period